How are financial advisors compensated?
As you engage an advisor, just like any professional, it is critical to understand how they earn their keep and what comes out of your pocket in return for the service they provide.
This is a topic of great debate right now as Canadian regulators work to redesign the financial services industry to protect client interests. If you can't articulate the financial exchange, chances are you need to clarify it.
There are two main forms of compensation you will find with advisors. Commission and Fee-based.
Commission: Advisors get compensated every time they perform a transaction on behalf of a client, such as buying and selling a stock. The amount charged can vary, though there are minimums.
Fee-based: Advisors charge a fee that is a percentage of the total assets they manage for a client. This fee is intended to cover the cost of the advisor providing advice in addition to trading and transactional costs. These accounts often come with annual limits on the number of trades allowed, just to ensure that clients don't take advantage.
There is a common belief that commission based advisors will focus more on pure investment portfolio management, while fee-based advisors offer a more complete service looking at your total wealth and life situation to offer advice. The fact is, the licensing level makes both types of advisors equally equipped to serve you in both of those ways.
It's better to identify the kind of advisor relationship you're looking for and then evaluate which compensation method would be more aligned to your needs. For example, if you don't want to do too much active trading and prefer more financial guidance, then commission-based advisors would be best for you, provided you find one who focuses on advice as a core part of his/her practice.
It is also critical to consider the incentives. Advisors paid transactionally will make more if they trade more, though there is strong regulatory enforcement in place to prevent advisors from acting outside of the best interest of their clients. Alternatively, a fee-based advisor will get paid based on your amount of assets, but they get paid even if they make no trades and your investments don’t grow.
There is currently a lot of discussion in the media about the role of financial advisors and how Canadians can protect themselves. Understanding compensation models is a critical component to make sure you don’t fall for myths. Any professional you engage for advice should be able to articulate their offering and the values surrounding their business.
A great advisor understands that their role is to guide you to think about your future, ask you questions that challenge your perspectives and help you create concrete plans and answers to all of life’s “what if this happened” questions.
In short, the intention here is to evaluate the incentives, structures and styles of different advisors so that you can have the confidence to choose the right one. Don’t be afraid to take the time to truly get to know the advisor you are working with and get to know their style.
To learn other tips and tricks you could apply when determining the fit of a professional for your current needs, check out our How to Choose a Professional Checklist.